12 Jan Terminology of Traditional and Tokenized Securities
Have you heard that 2019 will be “the year of the security token” and you are wondering if you should keep up with the news or stick to traditional securities as an investment or fundraising solution?
That is for you to decide after finding out all there is to know about each option. However, as you do your research, you will come across a series of terms you should become familiar with. We will review the most important ones and explain their meaning in the following lines.
Securities and Tokenized Securities Terminology Explained
- Securities – They are financing or investment instruments issued by companies or government agencies that denote ownership interest and represent evidence of debt, giving their holder an earnings share or a property distribution right. Examples include bonds, shares, debentures, options, notes, warrants, etc. They allow the holder ownership of an asset, property, or company without actually taking possession of it. Entrepreneurs and government agencies use securities to raise money from investors. In exchange for their investment, the investors will receive dividends, interest, or a profit share.
- Restricted Securities – These are a special category of securities that do not allow free trading. Owners willing to sell their restricted securities meet five requirements: 1) Ensure a holding period of 6 to 12 months, 2) provide current public information covering the nature of their business, their directors and officers’ identity, and their financial statements, 3) trade less than 1% of their outstanding shares, 4)complete the sales through Ordinary Brokerage Transactions, and 5) file a proposed-sale notice with the Securities Exchange Commission.
- Tokenized securities – Also known as security tokens, they are cryptographic tokens backed by tradable financial assets (securities). Just like traditional securities, they too pay dividends, interest, or profit shares to their holders. Compared to cryptographic tokens, they are subject to strict regulations and represent a safer investment.
- IPO (Initial Public Offering) – It is the process through which private companies offer securities to the public for the first time. Growing companies use this solution to raise money, while established firms turn to it in order to allow their owners to exit ownership partially or completely. Any security offerings following the IPO are referred to as secondary offerings.
- Private Placement – This is the alternative procedure for IPOs, allowing security issuers to address their offer to a specific group of potential investors. For example, some companies prefer to target more powerful investors, like hedge funds, banks, and specific corporations, without making their offer public, and don’t hesitate to set preferential prices for their securities. There are also companies that prefer to sell their stocks through both public offerings and private placements.
- Primary Market – It is the market where the creation and issuance of securities take place. It allows companies to offer securities like stocks and bonds to the public for the first time, in order to raise the funding they need. The transactions on this market occur directly between issuers and investors.
- Secondary Market – It is the market in which investors trade securities between them and turn their securities into liquidities. Issuers are rarely involved in this market, these transactions following the ones in the primary market. The most important secondary markets are the New York Stock Exchange (NYSE) and Nasdaq, but others have followed their lead as well and provide similar services.
- STO (Security Token Offering) – This is the cryptographic, simplified version of IPOs and private placements. Through it, companies can create their own tokenized securities and offer them to investors. The offers usually involve a pre-determined number of tokenized securities available over a specific period of time, for a fixed price. The issuer can make their offer public (investors have to comply with specific regulations) or target specific investor categories (SEC-registered U.S. investors, non-U.S. investors, etc.).
- SEC (U.S. Securities and Exchange Commission) – They are an independent government agency responsible with regulating and overseeing traditional and tokenized security offerings and transactions. They encourage full public disclosure, monitor U.S. corporate takeovers, and protect investors against fraud and manipulation attempts.
- Howey Test – It is a test used by the Supreme Court to determine whether a transaction qualifies as “investment contract”. According to it, cryptographic token transactions become tokenized securities transactions when they involve the following four elements: 1) a money investment, 2) in a common enterprise, 3) in exchange for profits, 4) secured by the efforts of others.
- STO calendar – List of security token offerings announced or scheduled to take place within the near future, meant to keep investors informed on the available opportunities and help issuers market their STOs. Many platforms have their own calendars, so it is important to check for new offerings regularly.
- Security token issuance platforms – As the name suggests, these are the platforms on which companies can create their own security tokens and launch their STO. The platform provides the necessary infrastructure and regulatory framework and brings issuers and investors together with another important category, providers, from which they can receive Legal, Advisory, KYC/AML, and Marketing advice and guidance. Some of the most famous security token issuance platforms to date are Polymath, Securitize, Harbor, Swarm, and Securrency. These platforms could be considered the primary market for traditional securities.
- Tokenized securities exchange platforms – These are high-frequency trading platforms that provide the necessary infrastructure and regulatory framework for trading tokenized securities. They are the equivalent of secondary markets for traditional securities. Some of the most common platforms to date are tZero, OFN (Open Finance Network), BankToTheFuture, Bancor, to name a few.
These are some of the most important terms you will come across during your research to determine whether traditional securities or tokenized securities are the best choices for your fundraising or investment needs.
Now that you are familiar with the terminology, understanding the difference between the two options available and choosing one should be easier. If you come across any other terms you do not understand or would like to know more about, don’t hesitate to mention them in a comment and we’ll add them to the list and explain their meaning!